If you invested in any business where effects of compounding over time affects the real return on the investment, then you need to know how to calculate the effective rate of return (also known as effective annual interest rate) of your investment. Here is an online calculator app that helps you calculate the interest amount and the effective rate of return on an investment capital (principal).
Interest & Effective Return Rate of Return/Effective Annual Interest Rate Calculator App
Features of the Interest and Effective Rate of Return Calculator App & How it Works
Below are some unique features of the interest and effective rate of return calculator app and how to use it:
User-Friendly and Responsive Interface
The app has a very user-friendly and responsive interface that can be used on any device, both mobile and PC. Also it is very interactive. So any online user can use it easily.
Calculates Both Interest Amount and the Effective Rate of Return
The calculator calculates both the interest amount and the effective rate of return on your investment capital, based on the nominal interest rate, interest type (simple or compound), interest frequency and investment period specified in the app.
Here is a breakdown of all the details you need to provide in the app:
- Principal: This refers to your investment capital.
- Interest Rate: The nominal interest rate offered by the investment platform or the business where you wish to invest.
- Interest Type: There are 2 options here – simple and compound. Always select Compound. But if the nominal interest will not be compounded, then you can select Simple. In the latter case, the Interest Amount will be calculated from the value you entered as Interest Rate in the app.
- Interest Frequency: This refers to the number of times the interest will be compounded. You have 4 options here: Monthly, Quarterly, Half Yearly and Yearly.
- Period (months): This refers to the total duration of the investment, that is how long the investment will last. You should specify it in months in the app.
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Once you have provided the required details above, tap the Submit button. Then the app will now calculate both the interest amount and the effective rate of return on your investment capital.
What is Effective Rate of Return?
Effective Rate of Return (also known as Effective Annual Interest Rate) is the rate of return an investment generated when all the factors that impact receipts are put into consideration. Some of these factors include: cost price of the instrument, the interest rate that the issuer agree to pay and any compounding used when calculating the interest paid. Most of the time, for simplicity, effective rate of returns is narrowed down to focus mainly on the impact of compounding, without considering the price at which an investment product was bought, which might differ from from its face value. But if it was stated in the terms of an investment product that there is no compounding of interest, then the effective rate of returns will be the same as the actual interest paid (nominal interest rate).
The formula for calculating Effective Rate of Returns (ROI) or Effective Annual Rate (EAR) is
Effective Rate Of Return = (1 + i/n)n – 1
where:
i = Nominal interest rate
n = Number of periods
Excel Formula for Calculating Effective Rate of Returns
There is also a formula in MS Excel for calculating effective annual interest rate (effective rate of returns). The formula is as follows:
=EFFECT (nominal rate, number of compounding periods). Then press enter key.
For example, to calculate the effective rate of returns of a 10% nominal rate, compounding monthly, I will enter the following formula in MS Excel spreadsheet:
=EFFECT(10%,12)
It will return 10.4713%.
NOTE: Make sure you set the number of compounding periods properly when using the Excel formula. This is because as the number of compounding periods increases, the effective rate of return also increases. A monthly compounding period will have a higher return than a quarterly or even half yearly compounding period.
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What is Return on Investment (ROI)?
Return on Investment (ROI) is an accounting/investment tool used to measure or evaluate the profitability of an investment. It can also be used to compare the profitability or efficiency of different number of investment. Return on Investment (ROI) is the total gain or loss from an investment over a specific period of time. It can also be seen as the change in cash flow or investment which an investor receives from an investment, which includes interest, dividend and profit from the investment within a specific period of time. Rate of returns can be calculated by the changes in the amount invested. If the change is positive, it implies that profit has been made. Whereas, if the change is negative, it implies a loss. It is usually expressed in percentage or ratio.
Also note that Return on Investment (ROI) is also used when evaluating the profitability of stocks and shares where dividends, interest and investment period are considered when calculating the final value of the investment.
The formula for calculating Return of Investment (ROI) is
ROI = (Final Investment Value – Initial Investment Value) / Initial Investment Value
Final investment value here refers to the amount realized after selling the investment.
For example, assuming you bought a house for $100,000 and after 2 years, you decided to sell it for $130,000. Applying the formula for Return on Investment (ROI) = ($130,000 – $100,000) / $100,000 = 0.3.
Coupons, cash dividends, stock dividends, interests, etc. are also included in the Final Investment value.
For example, assuming you bought 10 shares at an initial rate of $8, the initial investment will be 10 * 8 = $80. If the sharer is collecting $0.8 per share in cash dividends, for the 10 shares, the sharer will have 0.8 * 10 = $8. Then assuming that after 1 year, the share rate rose to $10. For the 10 shares, you will have 10 * 10 = $100. So your final investment value will now be $100 + $8 = $108. Applying the formula, RoR = ($108 – $80) / $80 = 0.325.
Note that if you wish to express ROI in percentage, you multiply the above formula by 100.
Internal Rate of Return (IRR) vs Return on Investment (ROI)
Internal Rate of Return (IRR) and Return on Investment (ROI) are two measurement tools used often in the investment world. Both are powerful tools that help investors know if a business is worth investing in and to also know how profitable an investment will be.
While Return on Investment (ROI) is an investment profitability metric used to evaluate how well an investment has performed by comparing the final investment value to the initial investment value. It is the percentage profit or loss on an investment divided by the initial investment value.
Internal Rate of Return (IRR) is mostly used by financial analysts to measure the estimated cash flows of investments over a specific period of time. It helps business owners and financial analysts to properly analyze capital-budgeting projects in order to understand the potential rates of returns over time and to also run some necessary comparison. This will help you know if the business is really worth investing in, considering its future cash flows. You can learn more about internal rate of returns and how to calculate it both manually and via MS Excel in this article.
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Conclusion
You have learnt all about our interest amount and effective rate of returns calculator app and how to use it, all about effective rate of returns, excel function for calculating effective annual interest rate, return on investment, internal rate of return (IRR) vs return on investment (ROI), etc. Feel free to use the app.
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